Lattice Models Fundamental Data Structures and Algorithms

• Published in: Financial Instrument Pricing Using C++ pp. 333 - 365
• Main Author: Duffy, Daniel J
• Format: Book Chapter
• Language: English
• Published: United Kingdom John Wiley & Sons, Incorporated 2018; Wiley
• Subjects: binomial method; C++ features; code maintainability; code reusability; FINANCE & ACCOUNTING; induction algorithms; lattice data structures; lattice models; layers design pattern; price options; trinomial method
• ISBN: 0470971193; 9780470971192
• DOI: 10.1002/9781119170518.ch11

This chapter concentrates on software design issues. It is important to decide how to design lattice data structures and to determine which C++ features to use in order to promote code reusability and maintainability. Ad‐hoc solutions are easy to program but are difficult to maintain while a layered approach demands more up‐front thinking. However, the resulting code tends to be more maintainable. Lattice models are well known and popular in computational finance. The chapter explains how to design a flexible software framework to price options using lattice models. The approach is based on a number of fundamental design principles. The chapter shows how the layers design pattern satisfies these design requirements, thus allowing one to create flexible software systems. It then describes the pricing of one‐factor European and American options using the binomial and trinomial methods. The chapter mainly focuses on the well‐known forward and backward induction algorithms.